Note 7. Fair Value Disclosures of Financial Instruments

9 Months Ended

Sep. 30, 2012

Notes

Note 7. Fair Value Disclosures of Financial Instruments

Note 7.                        Fair Value Disclosures of Financial Instruments

For all financial and non-financial assets and liabilities accounted for at fair value on a recurring basis, the Company utilizes valuation techniques based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market expectations. These two types of inputs create the following fair value hierarchy:

Level 1 - Quoted prices for identical instruments in active markets.

Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 - Instruments where significant value drivers are unobservable.

The following section describes the valuation methodologies we use to measure different assets at fair value.

Investments in fixed maturities and equity securities:

Available-for-sale securities included in Level 1 are equities with quoted market prices. Level 2 is primarily comprised of our portfolio of government securities, agency mortgage-backed securities, corporate fixed income securities, collateralized mortgage obligations, municipals, GSEs and certain preferred stocks that were priced with observable market inputs. Level 3 securities consist primarily of CMO securities backed by Alt-A mortgages.  For these securities, we use industry-standard pricing methodologies, including discounted cash flow models, whose inputs are based on management’s assumptions and available market information. Significant unobservable inputs used in the fair value measurement of CMO’s are prepayment rates, probability of default, and loss severity in the event of default. Significant increases (decreases) in any of those inputs in isolation would result in a significantly lower (higher) fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for loss severity and a directionally opposite change in the assumption used for prepayment rates. Further we retain independent pricing vendors to assist in valuing certain instruments.

Trading securities:

            Trading securities included in Level 1 are equity securities with quoted market prices.

Interest rate swap:

The financial liability included in Level 2 consists of an interest rate swap on IHC debt.  It is valued using market observable inputs including market price, interest rate, and volatility within a Black Scholes model.

The following tables present our financial assets and liabilities measured at fair value on a recurring basis, at September 30, 2012 and December 31, 2011, respectively (in thousands):

		September 30, 2012
		Level 1		Level 2		Level 3		Total
FINANCIAL ASSETS:
Fixed maturities available-for-sale:
Corporate securities	$	-	$	351,541	$	-	$	351,541
CMOs - residential		-		12,780		14,142		26,922
CMOs - commercial		-		-		560		560
US Government obligations		-		17,279		-		17,279
Agency MBS - residential		-		450		-		450
GSEs		-		50,170		-		50,170
States and political subdivisions		-		287,075		2,587		289,662
Total fixed maturities		-		719,295		17,289		736,584
Equity securities available-for-sale:
Common stocks		4,296		-		-		4,296
Preferred stocks - perpetual		15,800		-		-		15,800
Preferred stocks - with maturities		7,997		-		-		7,997
Total equity securities		28,093		-		-		28,093
Trading securities - equities		5,858		-		-		5,858
Total trading securities		5,858		-		-		5,858
Total Financial Assets	$	33,951	$	719,295	$	17,289	$	770,535
FINANCIAL LIABILITIES:
Interest rate swap	$	-	$	377	$	-	$	377

		December 31, 2011
		Level 1		Level 2		Level 3		Total
FINANCIAL ASSETS:
Fixed maturities available-for-sale:
Corporate securities	$	-	$	323,140	$	-	$	323,140
CMOs - residential		-		14,648		22,127		36,775
CMOs - commercial		-		-		538		538
US Government obligations		-		166,582		-		166,582
Agency MBS - residential		-		585		-		585
GSEs		-		59,851		-		59,851
States and political subdivisions		-		255,402		-		255,402
Total fixed maturities		-		820,208		22,665		842,873
Equity securities available-for-sale:
Common stocks		6,699		-		-		6,699
Preferred stocks - perpetual		21,738		-		-		21,738
Preferred stocks - with maturities		9,104		-		-		9,104
Total equity securities		37,541		-		-		37,541
Total Financial Assets	$	37,541	$	820,208	$	22,665	$	880,414
FINANCIAL LIABILITIES:
Interest rate swap	$	-	$	494	$	-	$	494

            It is the Company’s policy to recognize transfers of assets and liabilities between levels of the fair value hierarchy at the end of a reporting period.

At September 30, 2012, there were no transfers of assets and liabilities between Level 1 and Level 2 of the fair value hierarchy. No securities were transferred out of Level 2 and into the Level 3 category at September 30, 2012. The Company does not transfer out of Level 3 and into Level 2 until such time as observable inputs become available and reliable or the range of available independent prices narrow. No securities were transferred out of the Level 3 category in 2012. The changes in the carrying value of Level 3 assets and liabilities for the nine months ended September 30, 2012 are summarized as follows (in thousands):

		September 30, 2012
		CMOs
						States and Political
		Residential		Commercial		Subdivisions		Total
Beginning balance	$	22,127	$	538	$	-	$	22,665
Purchases of securities		-		-		2,135		2,135
Gains(losses) included in earnings:
Net realized investment losses		(1,212)		-		-		(1,212)
Other-than-temporary impairments		(231)		(473)		-		(704)
Net unrealized gains (losses) included in
accumulated other comprehensive loss		2,976		495		424		3,895
Sales of securities		(7,087)		-		-		(7,087)
Repayments and amortization of
fixed maturities		(2,431)		-		28		(2,403)
Balance at end of period	$	14,142	$	560	$	2,587	$	17,289

  The following table provides carrying values, fair values and classification in the fair value hierarchy of the Company’s financial instruments that are not carried at fair value but are subject to fair value disclosure requirements at September 30, 2012 and December 31, 2011 (in thousands):

		September 30, 2012				December 31, 2011
		Level 2				Level 2
		Fair		Carrying		Fair		Carrying
		Value		Value		Value		Value
FINANCIAL ASSETS:
Policy loans	$	28,182	$	22,042	$	29,511	$	23,109
FINANCIAL LIABILITIES:
Funds on deposit	$	280,367	$	279,947	$	418,823	$	417,310
Debt and junior subordinated
debt securities	$	46,146	$	46,146	$	48,146	$	48,146

The following methods and assumptions were used to estimate the fair value of the financial instruments that are not carried at fair value in the Condensed Consolidated Financial Statements:

(A)       Policy Loans

The fair value of policy loans included in Level 2 of the fair value hierarchy is estimated by projecting aggregate loan cash flows to the end of the expected lifetime period of the life insurance business at the average policy loan rates, and discounting them at a current market interest rate.

(B)              Funds on Deposit

            The Company has two types of funds on deposit. The first type is credited with a current market interest rate, resulting in a fair value which approximates the carrying amount. The second type carries fixed interest rates which are higher than current market interest rates. The fair value of these deposits was estimated by discounting the payments using current market interest rates. The Company's universal life policies are also credited with current market interest rates, resulting in a fair value which approximates the carrying amount. Both types of funds on deposit are included in Level 2 of the fair value hierarchy.

(C)       Debt

The fair value of debt with variable interest rates approximates its carrying amount and is included in Level 2 of the fair value hierarchy.